In the second of a three-part series on the state of the condo market, we look at one of the downturn's biggest opportunities—the buying of fractured condo deals.
One of the biggest opportunities for multifamily investors during the downturn has been in buying failed condo deals.
On the one hand is the fractured condo deal, where a minority of units in an existing condo tower has already been sold. Still, investors with the equity, and intestinal fortitude, have found some great bargains in cities such as Miami, Phoenix, and Las Vegas by taking on fractured developments. Far more attractive than the fractured deal is the failed condo development, particularly high-rise projects that boast luxury finishes, amenities, and high design. Such construction quality wasn't (and in some cases, still isn't) feasible for rentals—the costs wouldn’t pencil out—but as a deeply discounted acquisition of a not-yet-built or partially built project, these deals can work.
Consider Southwest Properties, a Halifax, Nova Scotia-based apartment owner of about 1,250 units, which began investing in U.S. multifamily in 2009. As part of its strategy, the company targeted new construction bulk condo deals and has purchased four so far in Florida for a total of 628 units, operating them as rentals until the for-sale market returns. Last month, Southwest acquired 224 units (out of 240 total units) in Tower II of the Oasis Grand project in Fort Meyers, Fla., estimating that it received a discount of 33 cents on the dollar in terms of construction, land, and soft costs. While Southwest couldn’t reveal the price, public records peg it at $35.9 million.
Indeed, for the past two years, Southwest has found significant bargains in the fractured and failed condo market. Unfortunately, those deals may not be around much longer. “There’s a limited time for these kinds of deals, and in South Florida, that time has passed,” says Omar Del Rio, vice president of acquisitions for Southwest. “You’re still able to purchase below replacement value, but you’re no longer getting 50 cents on the dollar or below. Right now, the prices are almost like retail.”
Obviously, when it comes to making fractured and failed condo deals work, investors need to tread cautiously.
One of the biggest considerations in nailing the right condo deal is financing, or the lack thereof.
Many national and regional banks will issue recourse bridge loans for the acquisition, at fairly high prices. But finding permanent debt for a fractured condo acquisition is difficult, even once a project is stabilized— Fannie Mae, Freddie Mac and the FHA have little or no appetite for them. “We go into these deals saying, it’s great to get financing afterwards, but you have to make sure they can work without it,” Del Rio says.
One of the first underwriting considerations is finding out whether the existing homeowners are paying their dues. “The solvency of the condo association is critical,” Del Rio says. “If the owners aren’t paying their dues, you’re buying into a problem, and nobody is going to lend you money there.”
Part and parcel to that is finding out how many foreclosures have already occurred at the property—a negative that can also be an opportunity, as a savvy investor may be able to pick up those foreclosed assets and add to their unit count.
For instance, Miami Lakes, Fla.-based The Kislak Organization recently purchased 130 out of 170 units at The Villas at Jasmine Park, a busted condo deal in Pensacola, Fla., as part of a three-property acquisition. But the company hopes to own all 170 units going forward.
“Owning 80 percent of the units, we’ll be able to have enough control over the place that we believe it’s a viable apartment complex,” says Tom Bartelmo, Kislak’s CEO. “But we’re going to be talking with the owners and the lenders on those purchased units to see if we can’t purchase them back at a fair price.”
Many investors simply don’t want the headache of a fractured condo deal, regardless of the discount. Home Properties has looked at acquiring several such deals, but “it always feels like there’s too many legal issues, back taxes, busted homeowners associations, you name it,” says John Smith, chief investment officer for the Rochester, N.Y.-based REIT. “It’s just not worth it for us to jump in.”
Still, the company has been able to take advantage of a few projects in the condo sector. In 2008, it purchased the land around Cobblestone Square, a failed condo development in Fredericksburg, Va. Single-family builder K. Hovnanian had plans for eight buildings, but stopped construction after completing just two.
Home broke ground in February for a planned eight Class A buildings, totaling 302 units, on the land around the condo buildings. “In 2008, it became clear that the economy was going south, and we were concerned about the rents we were going to be able to underwrite,” says David Gardner, Home’s CFO. “We mothballed it for a little while and now things have started to thaw out.”
Home Properties doesn’t have anything to do with the two existing condo buildings, though some common area costs will be shared with the condo association. The bigger issue is the precedent set by the luxury condos already there—Home is having difficulty measuring demand for high-end, rental units in Fredericksburg.
“That’s one reason it’s a little bit of a stretch—the market is just not used to real A-quality garden apartments; there’s not a lot of competition to compare to,” Gardner says. “We’ve set the bar a little lower in our underwriting than what will actually be achieved because of that.”